21世纪经济报道记者吴斌 上海报道

At the end of 2023, the market was expecting 2024 to become a "year of interest rate cuts" with the Fed cutting interest rates six to seven times. The Fed’s tone of voice has once been dovish as well, but now it seems to be nothing more than a "dream".

In the first quarter of 2024, the U.S. CPI rose instead of falling for three consecutive months, and the market and the Fed's expectations for a quick rate cut came to naught. Fed officials, who "miscalculated" again, have become more cautious, expecting only one rate cut this year in the June dot plot. Stepping into the second half of 2024, Fed Chairman Jerome Powell also took a cautious step at the congressional hearing, hinting that interest rate cuts are imminent, but he is silent about the specific timing.

Erin Browne, managing director and multi-asset portfolio manager of global bond giant PIMCO, said in an exclusive interview with the 21st Century Business Herald that the inflation rate in the U.S. is declining at a slow but gradually decreasing rate, which is a bumpy road, and the "last mile" of anti-inflation is full of challenges, and it will not return to about 2% smoothly.

Reflected in monetary policy, Browne expects it is difficult for the Fed to cut interest rates aggressively. Historically, the Fed has typically cut rates by about 250 basis points in a rate cut cycle, but because inflation will remain high for longer and the economy is resilient, Browne expects this rate cut cycle is likely to be only about 125 basis points, meaning that rates will still be in restrictive territory even if the Fed cuts rates.

Looking ahead, Browne is bullish on fixed income investments, which enjoy the advantage of interest return, capital return potential and diversification. The growth of AI and tech giants is a long-term trend that is likely to continue to lead the market in the coming years, and may even remain ahead of the curve in longer supercycles. In the long run, the 60/40 portfolio strategy is still a good investment choice.

(managing director and multi-asset portfolio manager of PIMCO)

Hard for the Fed to cut rates aggressively

21st Century: At a time when Wall Street is divided on the U.S. inflation and the economic outlook, do you think inflation can smoothly return to the 2% target? Can the U.S. economy avoid a recession?

Browne: The U.S. inflation is coming down at a slow but gradually decreasing pace, and we think it's a bumpy road, and the "last mile" of anti-inflation is challenging and won't be smooth sailing back to around 2% target. We don't expect inflation to fall to 2% in 2026, but it will be around 2%.

How can inflation come down to 2% faster? We think this will require a recession. But a recession is not the most likely base case scenario for the next few years. The U.S. economic growth is slowing and is expected to fall to about 2.4 percent this year and could fall below trend of 2 percent next year, but will still remain positive.

21st Century: The U.S. economy as a whole has shown resilience, with inflation falling slower than expected. Market expectations for the number of Fed rate cuts have narrowed sharply from the beginning of the year. What are your expectations for the Fed's monetary policy going forward?

Browne: In the current environment, we still think the Fed can cut rates, but not in a full-blown rate cut cycle. Historically, the Fed has typically cut rates by around 250 basis points in a rate cut cycle, but because inflation will remain elevated for longer and the economy is resilient, the cut this time could be around 125 basis points. The Fed is likely to start cutting rates once in the third quarter of this year and continue at a measured pace through year end 2025.  This means that even if the Fed cuts rates through 2025, the rate will still be in restrictive territory. The Fed may need to cut rates by about 225 basis points to return to the neutral level, and a 125 basis points cut would mean that monetary policy will remain tight.

21st Century: From a corporate perspective, how have high interest rates affected their financing? What are the possible risks?

Browne: We just talked about that the Fed's monetary policy will remain in restrictive territory by the end of 2025. Higher interest rates for longer will create a greater divide between the strong and the weak in the corporate sector. Large, cash-rich companies can easily access capital markets to raise capital at an attractive level. But smaller companies that rely more on bank loans or private market funding will face increasing difficulties in refinancing and rollovers. Some sectors will face greater challenges in terms of growth and business model in the long term, such as commercial real estate, telecommunications, media, retail, and others. The gap between the strong and the weak in the economy is likely to widen.

It will take longer for inflation to return to target

21st Century: Some people believe that inflation will never return to 2% due to global headwinds and other reasons. What do you think?

Browne: Factors such as global headwinds have led to high inflation and a slower disflation cycle, but long-term inflation expectations remain stable in the 2% range, so we don't think the Fed has lost credibility and will maintain its goal of gradually reducing inflation to 2%.

The Fed did conduct a framework review a few years ago that changed their view of the inflation target, moving from a 2% "ceiling" to an "average" where inflation could be above 2% for a period of time and could be below 2% during a period of economic slowdown. Over the next few years, inflation will fall back to 2%, albeit for much longer and at a much slower pace than expected.

21st Century: The market is looking a little more dovish at the moment, and the Fed seems to be a little more hawkish. How do you see the divergence between the market and the Fed?

Browne: I don't think the Fed is exactly hawkish, they rely on data to make decisions. The Fed has some confidence at the moment, but more data is needed to further strengthen confidence in rate cuts.

The Fed's June dot plot projected one rate cut by the end of the year, which is fairly close to the two rate cuts that the market is currently pricing in. The market is somewhat optimistic about a faster rate cut cycle, but not much of a divergence. At the beginning of the year, the Fed expected two or three rate cuts, while the market expected six to seven cuts. Now we see that this divergence has narrowed, and the market and the Fed's forecasts have converged.

The AI boom is expected to continue to dominate the stock market

21st Century: The 60/40 portfolio strategy (60% equities, 40% bonds) was being challenged in recent years. Is it still a good investment strategy? How should investors allocate their assets?

Browne: The 60/40 portfolio strategy has averaged over 10% annual returns over the past two decades and is expected to perform similarly this year. The environment in 2022 was very special, with the Fed rapidly raising interest rates in response to high inflation, stocks and bonds underperforming, and the 60/40 portfolio strategy taking a hit. But in an environment where inflation is stable or even declining, a 60/40 portfolio strategy is likely to perform well. In the long run, the 60/40 portfolio strategy is still a good investment choice.

21st Century: The Nasdaq index has hit new all-time highs many times this year, and tech giants such as Nvidia, Microsoft and Apple have performed well amid the AI boom. Can they continue to lead the market in the future?

Browne: The growth of AI and tech giants is a long-term trend, but also a cyclical trend, with vitality and the potential to continue to lead the market in the coming years, and possibly even for longer supercycles. Even for Nvidia, whose stock price has soared in recent years, the forward price-to-earnings ratio is now essentially the same as it was three or five years ago, and the company's profitability has been growing, and this is likely to continue.

We are at an inflection point. There is a high demand for AI investments, especially in areas such as data centers, power supply, and the infrastructure needed to build and drive data centers. Companies such as Nvidia are currently in short supply of products, and they are about to launch many new products, which will continue to support profitable growth, and more businesses will benefit in the future. Artificial intelligence has more room for growth than other fields.

Fixed income investing has a triple advantage

21st Century: Fixed income has become more attractive these days. How do you see the future of fixed income investing? Which regions have more investment potential?

Browne: We've moved from an environment where there are no alternatives to equities to one where there are alternatives to equities, and there are three major advantages to investing in fixed income right now. First, fixed income assets have a significant interest return, and the initial yield level of core bond assets is very high, exceeding 5%. The second is the potential for capital returns from fixed income assets, with some developed and emerging market central banks already cutting interest rates, and the Fed will cut rates later this year, the price of fixed income assets is expected to rise. Finally, there is the potential for diversification outside of equities. As inflation declines, equities and bonds return to the traditional negative correlation, which also supports a greater allocation to fixed income assets in portfolios.

On a risk-adjusted basis, fixed income assets actually look more attractive than equities. Regionally, developed markets outside the U.S. are likely to have faster rate cut cycles, so we prefer to hold fixed income assets in markets such as Canada, Australia, and the United Kingdom rather than the U.S.

21st Century: Risk assets such as stocks and safe-haven assets such as gold have risen this year. What do you think of this phenomenon? Why is gold still outperforming when real interest rates remain high?

Browne: On the one hand, the stock market has been doing very well, constantly hitting new highs. The U.S. economic growth is resilient, and the Wall Street has revised corporate earnings expectations and equity market targets upward. On the other hand, the price of gold has also broken historical records several times. In times of high inflation, people will seek physical assets, and gold is a store of wealth in a high-inflation environment, seen as an inflation-resistant asset, and also a safe-haven asset. In addition, central banks and large sovereign wealth funds in many countries are increasing their holdings of gold to diversify their assets.

Despite high real interest rates, gold has hit several record highs this year and is likely to rise in the future. As long as trade tensions between the U.S. and other countries exist, the demand for gold will exist. Gold is one of the beneficiaries of many countries looking for reserve assets that can store wealth and spread the risk of the dollar.

Explore investment opportunities in China

21st Century: Perception of China's capital market is now divided; some are optimistic, while others are gloomy. What are your thoughts? Which industries offer greater opportunities?

Browne: China's growth target of 5% in 2024 is likely to be driven in part by the recovery and growth of Chinese exports. The challenge ahead is that the engine of trade growth in 2025 may face uncertainties in the global political environment, and China may need more fiscal stimulus next year, especially for Chinese consumers, to inject momentum into economic growth.

The biggest constraint facing China now comes from the real estate sector, and investment in related areas needs to be considered. China's tech sector is very cheap compared to the rest of the world, and the component manufacturers driving China's export growth are attractive. In addition, as China's economy matures, those sectors that build and support China's social security system are expected to benefit and become attractive in the long run. International investors need to focus on sectors in which the Chinese government is investing, rather than those that are scaling back investment, and there will be more opportunities in high-tech industries such as artificial intelligence in the future.

21st Century: The 2024 U.S. presidential election has become the focus of the world. How do you see the impact of the election? What are the possible definitive trends?

Browne: We think the biggest loser in the U.S. election will be its own finances. The question is not whether the fiscal deficit will increase after the election, but how much. Under both the Republican Party and the Democratic Party, the United States fiscal deficit will worsen.

Whoever is elected, we may all see more tariffs, the Democratic Party administration may use tariffs and export controls tactically, the Republican Party administration may use tariffs strategically. Trump has already hinted at 10% tariffs on the rest of the world and 100% tariffs on cars made in Mexico, and NAFTA may have to be rewritten or restructured.